Between October 1929 and July 1932, the Dow Jones Industrial Average fell from 381 to 41, a fall of 89%. Leading up to this, the market had been on a nine-year bull run that saw the Dow increase tenfold. This was the greatest stock market fall in history. The index did not reach 381 again until 1954.
If you are going to invest successfully, you need to be able to make an assessment of the current state of the market and likely future scenarios. For this, you will need to have some historical perspective – otherwise you will be flying blind. A great many people in the financial services industry constantly advise that it is impossible to time the market, so you shouldn’t bother to try. This proposition is examined in this chapter.
As well as wanting to make money in the stock market, another crucial consideration is the preservation of your capital. So you need to understand the crashes as well as the bull runs.
In this section, the behavior of the markets is described mainly through the lenses of the S&P 500, which represents about 75% by capitalization of the entire US market in publically traded shares, and the FTSE 100, which represents about 80% of the London Stock Exchange market capitalization. It is widely accepted that the S&P 500 is the most important stock market index, and it influences all other major world indices. There is a clear correlation between the S&P 500 and the FTSE 100 indices, though in percentage terms, the S&P 500 has strongly outperformed the FTSE 100, with a particularly strong surge ahead from 2013. The FTSE 100 global companies simply could not keep up with the US powerhouse of the S&P 500.
For the purposes of this chapter, recent history starts in 1987, the year of the Black Monday stock market crash. We take a look at the 1987 crash and then the crashes of 2001 and 2008 that got underway in 2000 and 2007, respectively. The 1987 fall, around 34%, was not as severe as the dramatic falls that took place in 2001 and 2008, which were around 50%. However, the 1987 crash was notable by the sheer speed of the fall, with the S&P 500 losing 20.6% in a single day, infamously remembered as Black Monday. […]